Walmart: This Is A Disaster (NYSE:WMT)

Walmart Supercentre storefront

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Thesis

After Q2 earnings update, Walmart (NYSE:WMT) shares dropped almost 10% after hours. Long-term investors might argue: buy the stock on weakness. Be greedy when others are fearful. And I agree. But for now, Walmart’s results are a disaster. Notably, Walmart has issued a second profit warning within just 10 weeks. This implies a highly negative read not just for the company, but also – and perhaps even more so – for the US economy. Given rising interest rates, high inflation, and falling asset, the US consumer’s confidence is fading and he/she is acting accordingly. Or, in the words of Walmart CEO Doug McMillon:

The increasing levels of food and fuel inflation are affecting how customers spend … U.S. inflation levels, particularly in food and fuel, created more pressure on margin mix and operating costs than we expected.

Walmart reinforces concerns of a slowing economy and I believe this is not yet the time to buy the dip. A 10% overnight drop for a blue-chip company such as Walmart is quite spectacular and could indicate an appealing buying opportunity in normal times. But don’t be fooled. These are not normal times. And Walmart’s earnings cut is a disaster not just for the company, but for the entire market.

Earnings Update

Despite the clearly negative big-picture headline, Walmart delivered strong top line results (arguably due to price inflation). For the quarter, total revenue is expected at $141.6 billion, representing an increase of about 2.5% year-over-year. Retail, e-commerce, Sam’s Club, and advertising, all business verticals recorded an increase. However, expenses have increased even more. In fact, operating expenses as a percentage of net sales increased by 45 basis points. The company achieved net operating income of about $5.3 billion, which is a decrease of 23.0% year-over-year. That said, Walmart’s results were actually okayish, in my opinion.

What spooked the markets was the guidance: Walmart warned that its operating earnings would decrease by approximately 11% to 13% over the full financial year. This is a significant downgrade from the company’s statement in May, when Walmart warned that operating income would be down only by about 1% for the full year. Unsurprisingly, Walmart’s shares dropped sharply on the announcement and the results also sent peers lower: Amazon (AMZN) shares fell about 4%, Target (TGT) fell 5%, and Costco (COST) lost 3%. (reference after hours data on July 25th).

Walmart price performance

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What Walmart’s Results Imply

Walmart’s profit warning will re-kindle a strong debate regarding the financial health of the US consumer. Walmart’s results indicate that consumers are spending less on discretionary items to afford an undisrupted consumption of necessities, including food. That said, Walmart has indicated considerable weakness with regards to the company’s apparel sales, as the world’s largest retailer is discounting merchandise to clear excess inventory. And in order to offload unsold stock, the company must accept lower margins. This headwind does not appear temporary, but structural — given that consumer purchasing power for non-essential shopping gets squeezed by high inflation and rising rates. That said, I would understand if investors turn structurally more cautious on names such as NIKE (NKE), Lululemon (LULU), and Bath & Body Works (BBWI).

Walmart Still Expensive

It is worth noting that Walmart is still trading relatively expensive, although the stock is down about 15% YTD. In fact, Walmart currently trades at an x22.6 one-year forward P/E multiple, which is about 12.5% more than the relative aggregate sector valuation. Similarly, the company’s price-to-book multiple indicates a 51% premium, anchored on an x4.4 multiple for Walmart versus x2.64 for the sector.

Walmart Relative Valuation

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Notably, Walmart’s premium cannot be justified by above-industry growth. In fact, Walmart’s year-over-year revenue growth is about 80% lower than the sector median. Seeking Alpha records about 11% for the sector versus 2% for Walmart. Respectively, EBIT growth is about -15 for Walmart as compared to +5% for the industry median.

Investor Recommendation

Personally, I see Walmart’s results as a highly negative primer for the health of the US/global economy. In my opinion, we are in the early innings of a sharp recession. Thus, although I like Walmart stock with respect to a long-term investment horizon, I do not believe that the stock has found a bottom yet. Walmart is currently trading at a 2023 P/E of about x23 and I believe an x15 – x18 multiple would be justified given the current macroeconomic environment. That said, I see about ~20% downside before I view Walmart shares as a buying opportunity. In the meantime, I advise to stay on the sideline.

There could be an interesting trade opportunity for investors who are comfortable trading options and seeking to accumulate Walmart stock despite the macroeconomic concerns. Specifically, given the elevated volatility levels, investors could write December 16th dated 105 Strike PUTs and collect a 2.3% premium (about 10% annualized). Selling PUTs at a 10% OTM strike would lower the purchasing price and thus support investors with a margin of safety, which is strongly needed in light of the current market conditions.

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